In a previous edition of Surety Corner, we discussed the main components of a surety terms letter.
This letter is issued at the outset of a surety relationship and dictates the terms of support that the surety has put in place for a contractor.
Items such as rates, security requirements, facility limits, financial reporting expectations and financial covenants are outlined – begging the question, which of these items is the most important?
The answer to this question is, it depends on what is important to you.
The similarities between the surety world and construction world are much more striking than one may think. Both the construction and the surety market in Canada have experienced numerous new entrants in recent years, with many of the long-term players grappling with how to handle the new wave of competition. One thing is certain, increased competition breeds the need to define your value proposition.
Let’s explore what some typically attractive terms mean for you as a contractor.
Reduced or limited security requirements
There is no doubt that minimizing a business owner’s personal and corporate liability is top of mind for contractors.
In an environment where risk is being distributed throughout the entire construction pyramid, providing guarantees on behalf of operating companies, holding companies and business owners personally can be a daunting thought.
There are a number of steps that can be taken to reduce the liability associated with your surety facility, such as:
- Limit or remove the guarantees provided by related companies;
- limit or remove the personal guarantees of the business owner; and
- include clauses excluding specific assets, such as personal residences, from the personal guarantees of owners.
- These suggestions will of course limit the risk associated with your bond facility. That being said, there is a delicate balance to be kept.
In order to maintain a surety facility, an adequate amount of security must be held relative to the risk being taken on by the surety. Ensuring your operating entity’s balance sheet remains well capitalized, with excess profits being sent via dividend to holding companies is one way to do this.
Minimizing inter-company loans as well as eliminating cross corporate bank guarantees will also help “wall off” the operating entity to ensure funds held outside the business are not at risk.
Remember, the trade off to reduced security requirements is often the size of facility that can be obtained. A strong surety broker will ensure a balanced approach is taken to meeting the demands of the business, while also minimizing unnecessary liability.
Lesser financial reporting requirements
In the world of credit, financial reporting requirements can be measured in two categories, frequency of reporting and report quality.
The frequency discussion is a simple one. If you are a new or growing contractor, reporting requirements are likely to be quarterly or semi-annual. Quarterly financial reporting may seem onerous and time consuming, which is understandable. That may lead one to seek a relationship where less reporting is required. This can be a time saver, but at what cost? Any strong relationship starts by getting to know one another and building trust.
By spending the time to do that with frequent financial “check-ups,” your surety partner will begin to reciprocate that trust by extending further credit, improving pricing and even reducing security requirements as discussed above.
The quality of your financial reporting is the other facet of this discussion. Notice to Reader (lowest quality report) financial statements have become a growing trend within the industry. They are cheaper to obtain and for small contractors are a cost-effective way to have an external accountant prepare financial documents in order to secure a bonding facility.
The sacrifice is in the detail provided, which can be valuable to you as the business owner, specifically as it relates to revenue recognition. This lack of detail can also limit the bonding capacity available to your business.
Like the security you provide, reporting requirements are about balance. If you are unsure how a decision on financial statement quality may affect your bonding, speak with your surety broker about what would be best.
Cheaper rates
Let’s face it – if your surety broker tells you unreasonably high rates are best, you may want to find a new surety broker. No matter how you slice it, there is no inherent downfall to your rates decreasing.
The only caution we would provide is to weigh rates for what they are, a piece of the discussion but not the only piece. Providing the cheapest price does not guarantee the best quality of work, peace of mind in support or stability in service.
Rates should be table stakes and your surety broker should be able to ensure you are receiving competitive pricing. The difference between a perceived “good” rate versus a “great” one is often a couple hundred basis points, so may not be as significant as some may think.
Our advice: Factor in the cost of purchasing bonds as any prudent business owner would. But be cautious in souring a long-term relationship with your bonding company over promises of small rate decreases from the market. A surety company who trusts you long-term is going to provide more reliable support, communicate effectively if challenges arise and likely require less security or reporting than a new partner may.
Conclusion
In an ideal scenario, endless capacity would be available with no security, minimal reporting and at a cheap cost. In reality, that is not practical, so lean on your surety broker to guide you as to what area of focus is most beneficial to your business.
Every business is different, which is why all of these items are considered in concert with each other.
Matt Manol is the manager of surety for FCA Insurance. If you are seeking advice, guidance or feedback on your surety relationship, please contact us at surety@fcainsurance.com.
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